1/12/2012

Greece’s private sector deal unlikely to be final act

Ugly acronyms in Europe often hide ugly ideas. The EFSF, short for European Financial Stability Facility, for instance, has not lived up to its billing of offering financial stability.

Now it is time for another acronym to have its time in the sun again: PSI is back in the headlines. Private sector involvement is the rather clunky name for the method of making banks, insurers and other investors take losses on their holdings of Greek government bonds.

Not for the first time, a PSI deal in Greece is imminent. Bondholders are braced for a net present value loss of about 60 per cent, although finer details are still being debated, and in the worst case could be held up again.

The saga is so lengthy – discussion of PSI in October 2010 arguably sparked the most serious bout of contagion in the two-year long crisis – that investors might be minded to dismiss the deal as almost irrelevant with the true action to be found in Italy or Spain. But the reality is that the Greek PSI deal is seeing many of the big issues regarding Europe’s future played out in Athens.

How these issues are settled, and in whose favour, could help set the direction for markets and the single currency for some time.

Few people come out of the PSI debate looking good. Germany and France pushed ahead with it despite warnings from the European Central Bank about the contagion it would, and did, unleash. At certain stages, banks have looked to be getting away with it lightly – even now a 60 per cent loss contrasts with bond prices of about 20 cents in the euro. Hedge funds have reportedly scooped up certain bonds in the hope of freeriding their way to full repayment while other investors suffer.

The most intriguing questions come out of how the PSI deal will affect the ECB and the International Monetary Fund. The ECB is the biggest single holder of Greek bonds.

Because of the PSI’s voluntary nature, the ECB has been able to keep its holdings out of any deal. That costs Greece tens of billions of euros in foregone debt relief.

But it also provokes a fierce reaction among the private sector bondholders expected to take the pain. One, Madrid-based Vega Asset Management, complained in meetings of the steering committee of creditors about the ECB refusing to accept losses on its own bonds.

The current deal is only likely to heighten questions about the ECB’s stance. Greece is likely to copy the recommendations of one of its lawyers, Lee Buchheit, and insert collective action clauses into Greek bonds retroactively. CACs, as they are known, allow a bond’s terms to be modified if a strong majority – often two-thirds or three-quarters – of bondholders agree. The change would then be binding on all parties. The problem with this, as Joseph Cotterill, my colleague on FT Alphaville has noted, is that the ECB would theoretically be subject to any change through the CACs as well. But the ECB has certain weapons that other bondholders do not have. First, it could try to have its holdings somehow excluded from having CACs inserted. More importantly, it is propping up the Greek banking system through its various liquidity measures, giving it a very powerful weapon in negotiations with Athens.

Some bondholders say they have proposed a potential compromise under which the ECB would accept it would not be paid back in full but would not lose money. Analysts estimate that it bought the bonds at a price of about 65-75 cents in the euro; BarCap thinks its mark-to-market losses are about €20bn-€25bn.

Given the ECB’s dislike of PSI, it seems unlikely perhaps that it will suddenly agree to join in. But its stance is hugely important, especially given that many investors believe that only the central bank can help stem the crisis by buying sovereign debt on a far larger scale than currently.

The PSI deal also shines a light on the IMF’s role in Europe. Many bondholders express irritation with the IMF’s hard line in negotiations, pushing for bigger losses. Some argue that officials citing current Greek bond prices is not a good idea as policymakers can help influence them by calling for larger haircuts.

The complications over Greece’s second programme suggest that the IMF will be cautious about intervening in Europe too hastily. Portugal, due to return to the markets next year but which still has 10-year bond yields close to 13 per cent, could soon offer a test.

The Greek PSI deal, assuming it comes, is likely to be the complex and opaque solution that most actors in the eurozone drama seem to like, meaning that it will be tricky for lay people to see who has won or lost. But it is unlikely to be the last act in Greece. To get to anything resembling true sustainability for Greece’s debt burden, questions will have to be asked about not just banks’ holdings but those of the ECB and the official loans from Europe and the IMF. Investors hoping to have heard the last of Greece may well be disappointed for some time.